Hedge funds squeezed as lenders get tougher, producing negative cycle

Date: Friday, March 7, 2008
Author: Carrick Mollenkamp & Serena Ng, Wall Street Journal

From the WSJ: The financial turmoil is taking on a new dimension: Banks that lent money to hedge funds and other big risk-takers are asking for some of it back. Loans from banks and brokerages had allowed hedge funds, which manage some $1.9 trillion in clients' money, to amass many times that amount in investments. But as the value of mortgage-backed bonds and other investments has dropped in recent weeks, the lenders are demanding that borrowers put up more cash or assets.

This is producing a negative cycle that has policy makers deeply worried. When investors rush to dump assets, prices fall and lenders feel compelled to make further demands, or "margin calls," which cause even more selling.

So far, the turbulence touched off last summer hasn't resulted in many big hedge-fund blowups. If that changes, banks and other financial firms could end up holding even more hard-to-sell securities. Already, their troubled investments, especially in securities tied to mortgages, have cost them some $140 billion in write-downs.

Stock investors took note yesterday. The Dow Jones Industrial Average fell 214.60 points, or 1.8%, to 12040.39. Financial stocks led the way, with Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. all declining by more than 2.5%.